chapter 1: financial account - ibrahim sameer · pdf filechapter 1: financial account 2014 ......

Chapter 1: Financial Account 2014

1 Ibrahim Sameer Advance Certificate in Business Administration (ACCG – AVID College)

Accounting

Advance Certificate in Business

Administration – Study Notes

Chapter 1: Financial Account



Chapter 1: Financial Account

Financial accounts - overview

There are two main forms of accounting information:

(1) Financial Accounts, and

(2) Management Accounts

Financial Accounts - A Definition

Financial accounts are concerned with classifying, measuring and recording the transactions of a

business. At the end of a period (typically a year), the following financial statements are

prepared to show the performance and position of the business:

Profit and Loss

Account

Also known as the income statement. Describing the trading performance of

the business over the accounting period

Balance Sheet

Statement of assets and liabilities at the end of the accounting period (a

"snapshot") of the business

Cash Flow

Statement Describing the cash inflows and outflows during the accounting period

Notes to the

Accounts

Additional details that have to be disclosed to comply with Accounting

Standards and the Companies Act

Directors' Report

Description by the Directors of the performance of the business during the

accounting period + various additional disclosures, particularly in relation to

directors' shareholdings, remuneration etc

http://www.tutor2u.net/business/accounts/profit_loss_account.htm

http://www.tutor2u.net/business/accounts/profit_loss_account.htm

http://www.tutor2u.net/business/accounts/balance_sheet.htm

http://www.tutor2u.net/business/accounts/accounting_conventions_concepts.htm

http://www.tutor2u.net/business/accounts/accounting_conventions_concepts.htm



Financial accounts are geared towards external users of accounting information. To answer their

needs, financial accountants draw up the profit and loss account, balance sheet and cash flow

statement for the company as a whole in order for users to answer questions such as:

- "Should I invest my money in this company?"

- "Should I lend money to this business?"

- "What are the profits on which this company must pay tax?"

Company Law Requirements for Financial Accounts

Every UK company registered under the Companies Act is required to prepare a set of accounts

that give a true and fair view of its profit or loss for the year and of its state of affairs at the year

end. Annual accounts for Companies Act purposes generally include:

- A directors’ report - An audit report - A profit and loss account - A balance sheet - A statement

of total recognised gains and losses - A cash flow statement - Notes to the accounts

If the company is a "parent company", (in other words, the company also owns other

companies - subsidiaries) then "consolidated accounts" must also be prepared. Again there are

exceptions to this requirement (see consolidated accounts).

Comparative figures should also be given for almost all items and analysis given in the year end

financial statements. Exceptions to this rule are given individually. For example, there is no

requirement to give comparative figures for the notes detailing the movements in the year on

fixed asset or reserves balances.

Accounting - The Profit & Loss Account (or Income Statement)

Income statement (overview)

The income statement is a historical record of the trading of a business over a specific period

(normally one year). It shows the profit or loss made by the business – which is the difference

between the firm’s total income and its total costs. The income statement serves several

important purposes:



Allows shareholders/owners to see how the business has performed and whether it has

made an acceptable profit (return)

Helps identify whether the profit earned by the business is sustainable (“profit quality”)

Enables comparison with other similar businesses (e.g. competitors) and the industry as a

whole

Allows providers of finance to see whether the business is able to generate sufficient

profits to remain viable (in conjunction with the cash flow statement)

Allows the directors of a company to satisfy their legal requirements to report on the

financial record of the business

The structure and format of a typical income statement is illustrated below:

Hamdan Private Limited

Income Statement 2012 2013

Year Ended 31 December MVR'000 MVR'000

Revenue 21,450 19,780

Cost of sales 13,465 12,680

Gross profit 7,985 7,100

Distribution costs 3,210 2,985

Administration expenses 2,180 1,905

Operating profit 2,595 2,210

Finance costs 156 120



Profit before tax 2,439 2,090

Tax expense 746 580

Profit attributable to shareholders 1,693 1,510

The lines in the income statement can be briefly described as follows:

Category Explanation

Revenue The revenues (sales) during the period are recorded here. Sometimes

referred to as the “top line” – revenue shows the total value of sales made to

customers

Cost of sales The direct costs of generating the recorded revenues go into “cost of

sales”. This would include the cost of raw materials, components, goods

bought for resale and the direct labour costs of production.

Gross profit The difference between revenue and cost of sales. A simple but very useful

measure of how much profit is generated from every MVR1 of revenue

before overheads and other expenses are taken into account. Is used to

calculate the gross profit margin (%)

Distribution &

administration

expenses

Operating costs and expenses that are not directly related to producing the

goods or services are recorded here. These would include distribution costs

(e.g. marketing, transport) and the wide range of administrative expenses or

overheads that a business incurs.

Operating profit A key measure of profit. Operating profit records how much profit has been

made in total from the trading activities of the business before any

account is taken of how the business is financed.



Finance

expenses

Interest paid on bank and other borrowings, less interest income received on

cash balances, is shown here. A useful figure for shareholders to assess

how much profit is being used up by the funding structure of the business.

Profit before tax Calculated as operating profit less finance expenses

Tax An estimate of the amount of corporation tax that is likely to be payable on

the recorded profit before tax

Profit

attributable to

shareholders

The amount of profit that is left after the tax has been accounted for. The

shareholders then decide how much of this is paid out to them in dividends

and how much is left in the business (“retained earnings” in the equity

section of the balance sheet)

Balance Sheet

Balance Sheet (overview)

A balance sheet is a statement of the total assets and liabilities of an organization at a

particular date - usually the last date of an accounting period.

The balance sheet is split into two parts:

1. A statement of fixed assets, current assets and the liabilities (sometimes referred to as

"Net Assets")

2. A statement showing how the Net Assets have been financed, for example through share

capital and retained profits.

The Companies Act requires the balance sheet to be included in the published financial accounts

of all limited companies. In reality, all other organisations that need to prepare accounting



information for external users (e.g. charities, clubs, partnerships) will also product a balance

sheet since it is an important statement of the financial affairs of the organisation.

A balance sheet does not necessary "value" a company, since assets and liabilities are shown at

"historical cost" and some intangible assets (e.g. brands, quality of management, market

leadership) are not included.

Example Balance Sheet

The structure of a typical balance sheet is illustrated below:

Ahmadubey Private Limited Balance

Sheet at 31 December

2012 2013

MVR'000 MVR'000

ASSETS

Non-current assets

Goodwill and other intangible assets 150 150

Property, plant & equipment 2,450 2,100

2,600 2,250

Current assets

Inventories 1,325 1,475

Trade and other receivables 4,030 3,800

Short-term investments 250 190

Cash and cash equivalents 1,340 780

6,945 6,245

Current liabilities

Trade and other payables 2,310 2,225

Short-term borrowings 350 550

Current tax liabilities 800 650



Provisions 290 255

3,750 3,680

Net current assets 3,195 2,565

Non-current liabilities

Borrowings 1,200 1,450

Provisions 140 140

1,340 1,590

NET ASSETS 4,455 3,225

EQUITY

Share capital 500 500

Retained earnings 3,955 2,725

TOTAL EQUITY 4,455 3,225

An asset is any right or thing that is owned by a business. Assets include land, buildings,

equipment and anything else a business owns that can be given a value in money terms for the

purpose of financial reporting.

Definition of Liabilities

To acquire its assets, a business may have to obtain money from various sources in addition to its

owners (shareholders) or from retained profits. The various amounts of money owed by a

business are called its liabilities.



Long-term and Current

To provide additional information to the user, assets and liabilities are usually classified in the

balance sheet as:

Current: those due to be repaid or converted into cash within 12 months of the balance

sheet date;

Long-term: those due to be repaid or converted into cash more than 12 months after the

balance sheet date;

Fixed Assets

A further classification other than long-term or current is also used for assets. A "fixed asset" is

an asset which is intended to be of a permanent nature and which is used by the business to

provide the capability to conduct its trade. Examples of "tangible fixed assets" include plant &

machinery, land & buildings and motor vehicles. "Intangible fixed assets" may include

goodwill, patents, trademarks and brands - although they may only be included if they have been

"acquired". Investments in other companies which are intended to be held for the long-term can

also be shown under the fixed asset heading.

Definition of Capital

As well as borrowing from banks and other sources, all companies receive finance from their

owners. This money is generally available for the life of the business and is normally only repaid

when the company is "wound up". To distinguish between the liabilities owed to third parties and

to the business owners, the latter is referred to as the "capital" or "equity capital" of the

company.

In addition, undistributed profits are re-invested in company assets (such as stocks, equipment

and the bank balance). Although these "retained profits" may be available for distribution to

shareholders - and may be paid out as dividends as a future date - they are added to the equity

capital of the business in arriving at the total "equity shareholders' funds".



At any time, therefore, the capital of a business is equal to the assets (usually cash) received from

the shareholders plus any profits made by the company through trading that remain undistributed

Balance Sheet - Current Assets

Current assets

This section of the balance sheet shows the assets a business owns which are either cash, cash

equivalents, or are expected to be turned into cash during the next twelve months.

Current assets are, therefore, very important to cash flow management and forecasting, because

they are the assets that a business uses to pay its bills, repay borrowings, pay dividends and so

on,

Current assets are listed in order of their liquidity – or in other words, how easy it is to turn

each category of current asset into cash.

The main elements of current assets are:

Inventories Inventories (often also called “stocks”) are the least liquid kind of

current asset. Inventories include holdings of raw materials, components,

finished products ready to sell and also the cost of “work-in-progress” as it

passes through the production process.

For the balance sheet, a business will value its inventories at cost. A profit

is only earned and recorded once inventories have been sold.

Not all inventories can eventually be sold. A common problem is stock

“obsolescence” – where inventories have to be sold for less than their cost

(or thrown away) perhaps because they are damaged or customers no

longer demand them. For these inventories, the balance sheet value should

be the amount that can be recovered if the stocks can finally be sold.



Trade and other

receivables

Trade debtors are usually the main part of this category. A trade debtor is

created when a customer is allowed to buys goods or services on

credit. The sale is recognised as revenue (income statement) when the

transaction takes place and the amount owed is added to trade debtors in

the balance sheet. At some stage in the future, when the customer settles

the invoice, the trade debtor balance converts into cash!

Most businesses operate with a reasonably significant amount owed by

trade debtors at any one time. It is not unusual for customers to take

between 60-90 days to pay amounts owed, although the average payment

period varies by industry. Of course some customer debts are not

eventually paid – the customer becomes insolvent, leaving the business

with debtor balances that it cannot recover.

When a business is doubtful whether a customer will settle its debts it

needs to make an allowance for this in the balance sheet. This is done by

making a “provision for bad and doubtful debts” which effectively

reduces the value of trade debtors to the total amount that the business

reasonably expects to receive in the future.

Short-term

investments

A business with positive cash balances can either hold them in the bank or

invest them for short periods – perhaps by placing them on short-term

deposit. Such investments would be shown in this category.

Cash and cash

equivalents

The most liquid form of current assets = the actual cash balances that the

business has! The bank account balance would be the main item in this

category.



Balance Sheet - Current Liabilities

Current liabilities

Current liabilities represent amounts that are owed by the business and which are due to be paid

within the next twelve months. Current liabilities are normally settled from the amounts available

in current assets. The main elements of current liabilities are:

Trade and other

payables

The main element of this is normally “trade creditors” – amounts owed

by a business to its suppliers for goods and services supplied. A trade

creditor is the reverse of a trade debtor. A business buys from a supplier

and then pays for those goods and services some time later – the period

depends on the length and amount of credit the supplier allows.

Short-term

borrowings

Amounts in this category represent the amounts that need to be repaid on

outstanding borrowings in the next year. For example, a business may

have a bank loan of MVR2million of which MVR250,000 is due to be

repaid six months after the balance sheet date. In the balance sheet, the

bank loan would be split into two categories: MVR250,000 as short-term

borrowings and the remainder (MVR1,750,000) in the borrowings figure

in non-current liabilities.

Current tax

liabilities

This category shows the tax liabilities that the business is still to pay to the

government. This will mainly comprise corporation tax, income tax and

Business tax and GST, TGST.

Provisions This is a category that can contain a variety of amounts due. For example,

it would include any dividends due to be paid to shareholders. More

importantly, it will also include any estimates of potential costs which the

business might incur in relation to known disputes or other issues. For

example, if the business is subject to legal claims or is planning to make



redundancies in the near future – then the likely costs of these issues needs

to be provided for in the balance sheet

Non-current liabilities: This category shows the longer-term liabilities that a business has. By

“longer-term”, we mean liabilities that need to be settled in more than one year’s time. This

would include bank loans which are not yet due for repayment.

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chapter 1: financial account - ibrahim sameer · pdf filechapter 1: financial account 2014 ......

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